It looks like someone linked you here to our printer friendly page.
Please make sure you go Back to Safehaven.com
for more great articles just like this one!

Clap Along if You Feel that Happiness is the Truth

By: Michael Ashton | Tuesday, March 4, 2014

It might seem crazy what I'm 'bout to say
Sunshine she's here, you can take a break
I'm a hot air balloon that could go to space
With the air, like I don't care baby by the way

- From "Happy" by Pharrell Williams

Cliff Asness and John Liew have an article
that is in the latest issue of Institutional Investor, discussing the
development, strengths, and shortfalls of the Efficient Market Hypothesis,
which underlies the Nobel award for both Fama (as a proponent) and Shiller
(as a skeptic) this year.One of the interesting points that Asness and Liew
make is that examinations of market efficiency depend on the "joint hypothesis" that
(a) prices move efficiently to represent correct values, and (b) the model
of values that they move to is correct. They point out that if prices seem
to deviate from fair value (as expressed by a model), that could mean
that either markets are inefficient/irrational, or that the model
is wrong (or both). And they suggest strengthening the EMH to include a limitation
on such models that they make some kind of sense - since a model that incorporates
irrational behavior might well-describe all sorts of crazy market action
but not be "efficient" in any sense that makes sense to us.

This may not be an irrelevant reflection, given the price events of today.
Stocks more than rebounded from yesterday's Ukraine-induced selloff,
implying that not only are stocks just as valuable today as they were yesterday,
but that they are even more valuable than they were before we found
out about escalating tensions in the Crimean. This seems to border on the "unusual
model" side of things - especially since nothing particularly soothing happened
today.

Earlier today, Reuters reported that one of the Russian threats made in response
to the vague declarations of the U.S. that "all options are on the table, from
diplomatic to economic" (pointedly leaving out "military," as Obama did yesterday,
because gosh knows we don't want the Russians to think that's even a possibility)
was that Russians
might not repay loans due to U.S. banks (or, presumably, European banks
if they joined any sanctions). This is a clever threat, in the old vein of "if
you owe $100, it's your problem; if you owe $1 billion, it's the bank's problem." Everyone
who thinks that economic sanctions are a no-brainer are correct, in the sense
that it would imply no brain.Russia
also tested an intercontinental ballistic missile. This was "viewed as
non-threatening and is not connected to what is going on in Crimea," which
is of course absurd: regardless of how long the test has been scheduled, someone
who was trying to "de-escalate" tensions would surely defer the test for a
week. The fact that the test happened is one of many signs today that Putin's
soothing words were hollow. All of the actions today, from additional
warships steaming towards the Crimean peninsula to ICBM launches and confrontations
between Ukrainian and Russian troops, were consistent with an escalating crisis
even as Putin said there was no "immediate" need to invade eastern Ukraine.

Stocks loved the idea that the conflict may be over, with the west simply
conceding the Crimea and Russia deciding that she is sated for the time being,
as ridiculously unlikely as that outcome actually is. And, as I fully expected,
we heard over and over today the Rothschildian admonition to "buy on the sound
of cannons." And indeed, they bought. Oh, how they bought. The S&P rose
1.53% and most European bourses were up 2%-3%. The expected comparisons were
made, to the performance of equities during and following the Cuban Missile
Crisis, the first Gulf War, and the invasion of the Sudetenland.

These comparisons are all nonsense. Here's why.

Event

Date

CAPE prior to

Sudetenland

June 1938

11.99

Cuba

Oct 1962

17.32

Kuwait

Aug 1990

16.17

Ukraine

now

24.87

This is what happens when people learn the "whats" ofhistory, but don't learn
the "whys." The Rothschildian point isn't simply to buy on the sound of cannons.
It's to buy when markets are cheap because of the sound of cannons.
And that is most assuredly not the case presently. If stocks had dropped 50%
because of the Russian invasion, I would have been at the front of the line
telling people to buy. It is reckless and feckless to buy when the market is
expensive, and there are cannons that suggest a higher risk premium
is warranted at least for a time.

Really, what is the risk here, today? Is the risk really that an investor
might miss the next 25%, because the world becomes not only safe, but safer
than it was a week ago, and a super-cheap market simply takes off? Or is there
some risk that an investor might participate in the next -25%? Good heavens,
surely the latter is a far greater risk right now. And, after all, Rothschild
also said "sell on the sound of trumpets" (it's always interesting how the
bearish parts get forgotten), so that if the crisis is over and the west is
victorious then you're supposed to be selling! Here I guess is my point: this
is not Rothschild's market.

And, as Asness and Liew might put it, the model that implies stocks are more valuable
after such an episode...might not be a rational model. But today, Pharrell
wins: clap along if you feel like that's what you want to do!>

You can follow me @inflation_guy!

Enduring Investments is a registered investment adviser that
specializes in solving inflation-related problems. Fill out the contact form
at http://www.EnduringInvestments.com/contact and
we will send you our latest Quarterly Inflation Outlook. And if you make sure
to put your physical mailing address in the "comment" section of the contact
form, we will also send you a copy of Michael Ashton's book "Maestro, My Ass!"

Michael Ashton is Managing Principal at Enduring
Investments LLC, a specialty consulting and investment management boutique
that offers focused inflation-market expertise. He may be contacted through
that site. He is on Twitter at @inflation_guy

Prior to founding Enduring Investments, Mr. Ashton worked as a trader, strategist,
and salesman during a 20-year Wall Street career that included tours of duty
at Deutsche Bank, Bankers Trust, Barclays Capital, and J.P. Morgan.

Since 2003 he has played an integral role in developing the U.S. inflation
derivatives markets and is widely viewed as a premier subject matter expert
on inflation products and inflation trading. While at Barclays, he traded
the first interbank U.S. CPI swaps. He was primarily responsible for the creation
of the CPI Futures contract that the Chicago Mercantile Exchange listed in
February 2004 and was the lead market maker for that contract. Mr. Ashton
has written extensively about the use of inflation-indexed products for hedging
real exposures, including papers and book chapters on "Inflation and Commodities," "The
Real-Feel Inflation Rate," "Hedging Post-Retirement Medical Liabilities," and "Liability-Driven
Investment For Individuals." He frequently speaks in front of professional
and retail audiences, both large and small. He runs the Inflation-Indexed
Investing Association.

For many years, Mr. Ashton has written frequent market commentary, sometimes
for client distribution and more recently for wider public dissemination.
Mr. Ashton received a Bachelor of Arts degree in Economics from Trinity University
in 1990 and was awarded his CFA charter in 2001.